APR vs Effective Rate

What does APR actually mean?

APR (Annual Percentage Rate) is the total cost of borrowing expressed as a yearly rate. Under the FCA's consumer credit rules (CONC App 1, which carries the Consumer Credit Act 1974 regime), it is worked out the same way by every lender and includes:

• the interest rate, compounded, so interest charged on interest is already inside it;
• compulsory fees, such as a card's annual fee or a loan's arrangement fee.

It leaves out optional fees: cash withdrawal fees, balance transfer fees, late and over-limit charges.

What is the difference between the advertised APR and the effective rate?

A credit card quotes two numbers. The purchase rate is the simple annual interest rate, used to work out each day's interest. The APR is that rate compounded over a year, plus compulsory fees.

So the APR already is the effective annual rate. The number that can mislead is the lower purchase rate, or a monthly rate (1.74% a month sounds small; it is 23% a year).

What is the difference between representative and personal APR?

Up to 49% of accepted applicants can be offered more, so check the personal APR in the pre-contract information before you sign.

How is credit card interest worked out each day?

Interest is charged daily on the balance, at the purchase rate divided by 365:

20.9% ÷ 365 = 0.0573% a day

On a £2,000 balance that is about £1.15 a day, or £34.36 over a 30-day month. Each month's interest is added to the balance, and that monthly compounding is what lifts 20.9% to a 23.0% APR.

Why can the real cost be higher than the APR?

1. Optional fees sit outside it. A 3% cash or balance transfer fee is extra.
2. Promotional rates end. A 0% deal reverts to the standard rate, often 22% to 25% APR.
3. Paying part of the balance. Pay less than the full statement balance and most cards charge interest on the purchases from the date you made them, not only on what is left. This is losing your interest-free period.
4. Cash withdrawals. Usually a higher rate, charged from the day you take the cash, with no interest-free period.

How do you work out a balance transfer payoff date?

Divide what you owe, fee included, by what you can pay each month, and check the answer against the length of the 0% offer.

£3,000 moved at a 3% fee = £3,090 owed. Over a 24-month 0% offer that is £128.75 a month.

Pay less and whatever is left when the offer ends starts accruing at the standard rate, so set a fixed monthly payment for the amount that clears it, not the minimum.

Is a personal loan cheaper than a credit card?

£10,000 over five years at 8% APR costs about £2,086 in interest (£201.43 a month). The same balance cleared over five years on a 23% APR card costs about £6,198. If card debt will take more than a few months to clear, a cheaper loan or a 0% transfer usually costs less.

How do you avoid paying interest at all?

Pay the full statement balance every month by the due date. Do that and the APR never applies to purchases: the interest-free period is typically up to 56 days from the purchase date.